Accounting Keypoints; Principles Of Double Entry; Accounting is a systematic process of recording, classifying, summarizing, and interpreting financial transactions to facilitate informed decision-making by stakeholders.
The principles of double entry are an essential part of the accounting process, as they ensure accuracy and reliability in financial reporting. In this class note, we will discuss the principles of double entry in detail, including the functions of source documents, books of original entry, accounting equations, ledger and its classifications, trial balance, types, and treatment of errors, and the use of suspense accounts.
a. Functions of source documents:
Source documents are the original records that provide evidence of a financial transaction. They serve as a basis for the preparation of accounting records and include invoices, receipts, bank statements, checks, and purchase orders, among others. The functions of source documents are as follows:
i. Provide evidence of a financial transaction: Source documents serve as proof that a financial transaction has occurred, and the details of the transaction are recorded accurately.
ii. Record details of the transaction: Source documents provide the details of the transaction, such as the date, amount, and nature of the transaction.
iii. Facilitate the preparation of accounting records: Source documents provide the necessary information to prepare accounting records, such as journals, ledgers, and financial statements.
b. Books of original entry:
Books of original entry, also known as daybooks or journals, are the first place where financial transactions are recorded. They are used to record transactions in chronological order and include the following:
i. Sales journal: Used to record credit sales.
ii. Purchase journal: Used to record credit purchases.
iii. Cash receipts journal: Used to record cash received.
iv. Cash disbursements journal: Used to record cash payments.
v. General journal: Used to record transactions that do not fit into any of the other journals.
c. Accounting equation:
The accounting equation is a fundamental concept in accounting, representing the relationship between assets, liabilities, and equity. It is expressed as follows:
Assets = Liabilities + Equity
This equation must always balance, as every financial transaction affects at least two of these elements. For example, if a business purchases equipment with cash, the accounting equation is affected as follows:
Assets (Equipment) increase = Liabilities (Cash) decrease + Equity (Retained earnings) decrease
d. The ledger and its classifications:
The ledger is a record of all the accounts used in the accounting system. It is used to record the details of all financial transactions and their effects on the accounting equation. The ledger is classified into two types:
i. General ledger: This ledger contains all the accounts used in the accounting system, such as cash, accounts payable, and accounts receivable.
ii. Subsidiary ledger: This ledger contains detailed information about a specific account in the general ledger, such as accounts receivable or accounts payable.
e. Trial balance:
A trial balance is a list of all the accounts in the general ledger and their balances. It is used to ensure that the total debits equal the total credits, indicating that the accounting equation is in balance. The trial balance is prepared at the end of an accounting period and is used to prepare financial statements. If the trial balance does not balance, it indicates that there are errors in the accounting records.
f. Types and treatment of errors and uses of suspense account:
Errors in accounting can occur due to various reasons, such as incorrect recording of transactions, incorrect calculations, and omission of transactions. There are two types of errors:
i. Errors of omission: These occur when a transaction is not recorded in the accounting records.
ii. Errors of commission: These occur when a transaction is recorded, but the details are incorrect.
To correct errors, the following steps can be taken:
i. Identify the error.
ii. Determine the impact on the accounting equation.
iii. Make the necessary journal entries to correct the error.
iv. Post the corrected entries to the ledger.
v. Prepare a new trial balance to ensure that the accounting equation is now in balance.
If the error cannot be identified, or if it is immaterial, it can be recorded in a suspense account. A suspense account is a temporary account used to hold entries that cannot be allocated to a specific account. The suspense account is later cleared when the error is identified, or the entry is written off.
Example:
Suppose a business purchased equipment for $10,000 but recorded it as $1,000. This is an error of commission. The impact on the accounting equation is as follows:
Assets (Equipment) decreased by $9,000 = Liabilities (Cash) increase by $9,000 + Equity (Retained earnings) no change
To correct the error, the following journal entry can be made:
Debit: Equipment $9,000
Credit: Cash $9,000
After posting the corrected entry to the ledger, the trial balance is prepared, and the accounting equation is now in balance. If the error had been immaterial or could not be identified, it could have been recorded in a suspense account until it was resolved.
Conclusion:
The principles of double entry are essential for accurate and reliable financial reporting. Understanding the functions of source documents, books of original entry, accounting equations, ledger and its classifications, trial balance, types and treatment of errors, and the use of suspense accounts are crucial for any accounting professional. By following these principles, businesses can maintain accurate records and provide useful information to stakeholders for decision-making purposes.
